IRS Audit Preparation Readiness Guide

Gather and verify these records before examination begins. IRS examiners will typically request them in the first Information Document Request (IDR).

Payroll Records

• Payroll registers for all pay periods in the examination years
• All Forms W-2 and W-2c issued during examination period
• All Forms 941 filed during examination period with payment receipts
• EFTPS deposit confirmations for all tax deposits
• Form W-3 (transmittal) for each year
• EFW2 electronic transmission confirmations (SSA)
• All Forms 1099-NEC / 1099-MISC filed during examination period
• Bank statements showing payroll account activity

Employee Records

• Form W-4 (current and historical) for all employees
• State withholding certificates for multi-state employees
• Employment contracts and offer letters
• Direct deposit authorization forms
• Employee expense reimbursement records and accountable plan documentation

Independent Contractor Records

• All independent contractor agreements for examination period
• Forms W-9 collected from all contractors
• Payment records and invoices for all 1099 recipients
• Documentation of behavioral and financial control analysis for classification decisions

Benefits & Fringe Records

• Group-term life insurance census and imputed income calculations
• Vehicle use policy and personal use mileage logs
• Cafeteria plan (§125) documentation and elections
• Educational assistance plan documentation (§127 qualified plan)
• Transportation benefit elections and receipts
• Moving expense reimbursement records (post-TCJA: must be included in wages)
• Executive compensation records (deferred comp, equity, nonqualified plans)

The IRS IDR is the examiner's opening request for documents. A well-organized, complete, and timely response signals to the examiner that the organization's records are in order — reducing the scope of examination. A disorganized or incomplete response does the opposite.

IDR Response Best Practices

• Acknowledge the IDR in writing within 5 business days even if requesting an extension
• Assign a single point of contact — preferably outside counsel or a senior payroll/tax professional
• Produce documents in labeled, organized binders or electronic folders corresponding to each IDR item number
• Include a cover letter with an index of documents provided
• Do not produce documents beyond what is specifically requested — over-production creates exposure
• Review everything for privilege before production — attorney-client and work product protections apply
• Keep a complete copy of everything produced to the IRS

Common First-IDR Document Requests

Reconciliation between W-2 totals and four quarterly 941s is the first analytical step examiners take. Unexplained variances immediately expand examination scope.

The Reconciliation Formula

Worker classification is the highest-risk area in employment tax examinations. If the IRS reclassifies independent contractors as employees, the exposure includes unpaid FICA (both shares), federal income tax withholding, FUTA, state unemployment, plus penalties and interest — potentially for multiple years.

Documentation to Support Independent Contractor Status

• Written independent contractor agreements specifying the project scope, deliverables, and that no employment relationship exists
• Evidence that the worker controls how the work is performed (not just what is delivered)
• Evidence that the worker provides their own tools, equipment, and workspace
• Evidence that the worker has profit/loss risk — they bear the cost of their own business expenses
• Evidence that the worker serves multiple clients simultaneously
• The engagement has a defined end — it is not indefinite
• The worker's services are not integral to the company's core business

Section 530 Relief Requirements

Fringe benefit examination focuses on whether employer-provided benefits are properly excluded from income (requiring a qualifying plan) or properly included (requiring correct imputed income calculation).

Three Possible Positions

Penalty Abatement — First-Time Abatement (FTA)

First-Time Abatement is available for failure-to-deposit, failure-to-file, and failure-to-pay penalties when: (1) the taxpayer has filed all required returns, (2) has paid or arranged to pay all tax due, and (3) has no prior penalties in the preceding 3 tax years. Request FTA in writing after the assessment.

Reasonable Cause Abatement

For FTD penalties and information return penalties, reasonable cause (facts and circumstances preventing compliance despite ordinary care) can eliminate penalties. Document: what happened, why it prevented compliance, what steps were taken to correct, and the timeline. Natural disasters, death/serious illness of a responsible party, and demonstrable reliance on professional advice are the strongest reasonable cause arguments.

• The IRS contacts individuals personally (rather than the organization) — TFRP investigation may be underway
• Criminal Investigation Division (CID) is involved — any contact from IRS-CI requires immediate counsel; do not speak with agents
• The IRS issues a summons for records rather than an IDR — the examination has escalated to a formal summons proceeding
• The examiner requests interviews with specific employees — interview preparation and representation are essential
• A 30-day letter or 90-day letter (Notice of Deficiency) is received — formal response deadlines are jurisdictional
• The proposed assessment exceeds what the organization can pay — installment agreements and offer-in-compromise options must be preserved before assessment
• Worker reclassification is proposed for a large population — the cascading FICA, FUTA, state, and benefit exposure can be existential